3 Trends to Watch in 2014

Last December, few people would have expected market returns of 30% in 2013. I entered 2013 modestly bullish and have consistently recommended staying invested throughout the year. But this time last year, I was steadfast in my belief that dividend-paying stocks would outperform in 2013 and that “the best values in the world” were in Europe.

Well, so much for that. U.S. stocks have trounced all their peers, and non-dividend-paying stocks have beaten the pants off of their dividend-paying brethren. As they say, “It’s hard to make predictions, especially about the future.”

So, all forecasts should be taken with a grain of salt. Markets are fickle and emotional, and they rarely do what they are “supposed to” within a given time frame. A good investment strategy is one that doesn’t require a precisely-timed forecast … and one that can be adjusted as market conditions change.

With that said, I’m going to offer three predictions for 2014:

Tapering Will Cause Bond Yields to Fall

I realize that this is a highly counterintuitive statement. The Fed, through its quantitative easing programs, has been absorbing a shocking amount of Treasury and agency debt at $85 billion per month. At various points in late 2012 and early 2013, the Fed bought in excess of 90% of new bonds being issued.

Still, we have to remember a few things. “Taper” does not mean quit. It means slowly reduce over a period of months or years, and that is exactly what the Fed announced following its December meeting. Rather than buy $85 billion per month, the Fed will be buying $75 billion, with further reductions dependent on the economy continuing to improve. And Bernanke and Yellen have made it very clear that tapering is not irreversible. If the economy starts to backslide, they can ramp up quantitative easing again at any time.

The bond market, not sure of what to expect, has priced in the worst. When the reality of tapering sets in, I expect a large rally in bonds and “bond-like” investments such as mortgage REITs.

And the Fed is not the only story here. Foreign investors — led by Japanese institutional investors — are aggressively buying U.S. Treasuries. Japanese purchases last quarter were the second-highest on record since at least the year 2000.

Bottom line, if you are in or near retirement and looking for quality income investments, this is a great opportunity to grab them at a bargain.

The U.S. Market Will Continue to Rise

Yes, the U.S. stock averages are up big this year. But this doesn’t indicate that there is a lean year ahead. In looking at the S&P 500’s returns since 1970, strong years in the market are generally followed by additional gains in the year that follows. There have been 9 years since 1970 in which the S&P generated price returns of 25% or more. In all but two cases, the S&P 500 went on to generate positive returns in the following year, and the average return the following year was 10.8%.

10.8% is a far cry from 30%, of course. But my point stands. Market history does not suggest that strong years are followed by weak ones.

Europe and Emerging Markets Will Outperform the United States

While I like the prospects for U.S. stocks in 2014, I see better opportunities abroad. Of course, I made a similar call this time last year, and I was wrong. “Cheap” European and emerging market stocks got cheaper, at least relative to their American peers.

As I wrote recently, many of the largest emerging markets are priced to deliver annual returns of 10%-20% or even more in the years ahead, whereas the U.S. market is priced to deliver returns that are barely positive.

Meanwhile, the Eurozone has emerged from recession — even if shakily — and China’s slowing appears to have run its course for now.

This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.